Should I Dip Into Savings To Max Out Roth IRA?

It’s getting very close to April 15th, which in addition to tax returns is also the funding deadline for IRAs in the 2009 tax year. A reader wrote in asking whether they should dip into their savings in order to fully fund their Roth IRA contribution for the year. I would imagine this is a common scenario this time of year.

Let’s say that your income is under the phase-out limits and you can contribute the full $5,000. (See this IRS page for more info on limits.) Perhaps you’ve contributed $3,000 so far. You can either take the remaining $2,000 out of your other accounts (emergency fund, car repair fund, sell stocks, etc.) and fully fund the entire $5k, or simply stop where you are.

An important fact to know here is that anyone can withdraw their Roth IRA contributions at any time, without penalty. (This means just your original contributions, not any earnings on those contributions.) However, you cannot retroactively make contributions to past years. In my example above, you couldn’t just contribute $5,000 + $2,000 = $7,000 next year.

Thus, if you feel that you would likely be able to max out in future years, it may be better to simply make your contributions now. It would be quite sad to miss out on a one-time opportunity for tax-free earnings forever! If you do need the money later, you can always withdraw it again. The early withdrawal process is not that complicated, although you will have some additional paperwork to fill out come tax time.

More details about the actual IRS fine print in this post: Can I Really Withdraw My Roth IRA Contributions At Any Time Without Tax Or Penalty?

There are always some possible wrinkles, of course. If it is truly an cash-under-the-bed emergency fund, you should know it make take a few business days to make an IRA withdrawal. In addition, if you really do foresee needing the money, then you may want to invest in conservative options like CDs or money markets. If you are selling stocks, you may be subject to taxes on capital gains. But you buy the same stock in the Roth IRA, you’ll be able to defer taxes on future gains.

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Yes, definitely. A Roth is no different than a savings account as long as you keep it invested in a money market fund. Well I suppose it doesn’t have the FDIC insurance.

I’m pretty sure I’m going to borrow money to max out my IRAs this year. The loan interest rate is 3.25%. So a traditional IRA would be a guaranteed 18% return on investment and a Roth would be, who knows what tax rates will be when I retire…50% maybe.

Something that seems to be lost in discussions such as this on numerous personal finance blogs (not just this one) is that any losses you incur in a Roth IRA are not tax-deductible. So if you go with only safe investments for your Roth IRA funds then yes, this acts like a savings account. But the second you decide to invest in anything with more than minimal risk, you have crossed into another area entirely.

I say this from personal experience. I put in $15k total into a Roth IRA over several years but withdrew ALL of it for just under $8k last spring to help with the down payment on our first house. I was glad I could use the Roth IRA money to help get us to a 20% down payment but needless to say wished it had happened at a slightly different time when I wasn’t eating a $7k+ loss on my own. If that money had been put in a taxable account instead, I would be deducting losses on my taxes for the next 3 years. Again, I reached my end objective of a full 20% house down payment so I’m happy but I do warn folks now that Roth IRAs aren’t entirely risk-free – know what you’re doing when you open and fund one.

What if you’re above the income limit and you contribute to a regular IRA and then convert it later in the year (in 2010 you can convert all regular IRA’s into Roth if you pay appropriate taxes – or in my case I won’t get to deduct anything for the regular IRA so I will be contributing post-tax dollars anyway)? Can you still withdraw it without penalty?

@ParatrooperJJ
The account has to be open for 5 years before you have an option to withdraw *earnings* without penalty. After 5 years, you can withdraw *earnings*: tax free if you are over 59.5, to pay for firsttime homebuyer costs, if you become disabled, or to go to your estate in the case of death. If you don’t meet one of those criteria OR it has not been open for five years, you pay a 10% penalty AND you owe income tax on the earnings.

Contributions can still be withdrawn any time without penalty regardless of how long the account has been open, or whether you have gained or lost money.

Definitely do it. I am going to raid a savings goal to meet my contribution limit this year- but I know that in x months I can repay my savings goal fund, or I can use my tax return to replenish the funds. Not so sure I would go as far as taking out a loan to fund my retirement though #1. Essentially, I am taking a loan out of my personal funds, but the idea of paying interest on invested funds inside a retirement account does not appeal to me.

I have been working this past year on starting and growing an emergency fund for myself. It’s now at $5,000. Would you recommend that I start and put this in an IRA? I’ve never started one because I didn’t think I could get it out until retirement. What would my fellow readers suggest?

I think it’s actually a good thing that these losses are not deductible. The money should be kept in your account as long as possible. Therefore, it should have little chance of having a negative return.

@Scott – Yes, I think a good rule of thumb is that if you are moving “safe” money into the Roth IRA like an emergency fund held in a bank, then it should stay invested in the same type of investment, like a money market fund.

To contribute or not to contribute? It would be a no-brainer if all investment options you have for regular taxable accounts were always available for IRAs. Unfortunately this is not the case. As an example, I have Ally 5yr CD @ 3.65%, one of the best on the market currently as already was mentioned. Can anybody suggest similar risk/reward/liquidity option available for IRA?

@Scott – Great point. With the markets recent declines, investors really need to understand the “Risk” involved with investing. My retirement account was down 40% the last few years but has bounced back nicely in 09.

Bottom-line, all investors need to understand that their is risk involved but eventually the markets should catch up. I say contribute!!!!

My experience has generally been similar options for IRA and savings accounts/CDs. The exception is clearly aggressive online banks. I Was surprised to recently learn Ally does not even offer IRAs, and many online banks don’t. No surprise, they don’t want to deal with the administration – which is why they offer higher rates.

That being said, look up CDs on bankrate. A lot of banks will offer CDs for your ROTH – same rates. You may be able to search IRA CDs specifically on bankrate.com – don’t remember. Whether the tax free perk is worth more than a current 4% interest rate is probably a case by case decision.

I actually keep a lot of my savings in cash in my ROTH. In the past I shopped CDs more aggressively, but it is kind of a PITA to roll the cash around every time a CD matures. So, I am personlly taking like 0% in a MMMF right now. I see it as rather temporary. The option have been like worse, worser, worst the last couple of years. The decade prior I Was able to lock in really good interest rates (5% – 6%). Just to point out generally there are better cash options – just not at the moment!

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